The Case for Equities

by: Russ Koesterich, CFA

With global equity markets up over 100% from their 2009 lows, many investors are questioning whether it is time to lower their strategic allocation to stocks. While there are no shortages of risks facing global equity markets, overall we find that most markets are fairly valued and arguably already reflecting some of the risks – particularly higher inflation and interest rates – that are likely to challenge the global economy.

We believe that over the long term, equities are still likely to produce higher nominal (inflation-adjusted) and real returns than other financial assets. We base our view on the long-term returns to equities – both real and nominal – and current valuation levels.

Historically, returns to equities have been consistently higher than other asset classes. This is to be expected from financial theory, as equities are more volatile than bonds or cash. On a real or inflation-adjusted return basis, equities have also outperformed – if you include emerging markets – other asset classes throughout most regimes. The major risk to equities remains a low growth/high inflation or "stagflation" environment.

In addition to their long-term track record, today equities have another advantage: They are reasonably priced relative to other financial assets. Many investors remain underweight stocks following the dismal performance of the asset class during the previous decade. The period from 2000-09 represented the worst 10-year stretch for equities since the 1930s.

We would argue the principal cause of last decade’s negative real returns was the absurd valuations of most equity markets in early 2000. While global stocks are no longer as cheap as they were at the 2009 bottom, current valuations are at or modestly below their long-term average. This suggests that multiple contractions, of the type we witnessed over the previous 10 years, should not be an impediment to global equity returns over the coming years. While investors need to be modest in their expectations, on a relative basis equities are likely to produce reasonable long-term returns.

Potential iShares Solution

Equities ACWI – iShares MSCI ACWI Index Fund
Mega Caps ACWX – iShares MSCI ACWI ex US Index Fund
OEF – iShares S&P 100 Index Fund
IOO – iShares S&P Global 100 Index Fund
Treasuries TLT – iShares Barclays 20+ Year Treasury Bond Fund

Read and listen to the full iShares Market Perspectives for June 2011.

Source: Bloomberg